Magazine

Online Extra: Hotels.com: Time to Check In?

June 23, 2002

Online travel and leisure companies are among the few dot-coms making money on Web. Within this small but growing club, not many have such attractive growth prospects as Hotels.com (ROOM), which peddles discounted hotel rooms over the Internet. Wall Street expects the Dallas company, known as Hotel Reservations Network until it acquired the more Net-friendly domain name earlier this year, to post profit gains of as much as 40% annually over the next several years (see BW Online, 5/24/02, "A One-Stop Site for Hotel Rooms?").

That's in part because Hotels.com, No. 86 on BusinessWeek's IT 100 list for 2002, was one of the first movers in the still largely untapped -- and highly profitable -- online hotel reservations market. Only about 4.5% of U.S. guest room revenues, or $3.8 billion, will come from Internet bookings in 2002, forecasts Forrester Research. It says that figure could rise to 8%, or $7.7 billion, by 2006. By comparison, more than 18% of airline tickets will be bought online this year, predicts online travel consultancy PhoCusWright.

"Hotels.com is very possibly the right company in the right place," says Steve Weinstein, a research analyst at Pacific Crest Securities in Portland, Ore. "They're a dominant player with an incredible opportunity, as hotel bookings move from offline to online." Weinstein has a strong buy rating on the stock, predicting that it could more than double, to $100, in the next 12 to 18 months. (The stock closed at $44.68 on June 12, representing a 123% jump from its post-September 11 low of $20.06 on Sept. 21.)

NOT IF, BUT WHEN. There's one big caveat for potential investors: Weinstein's price prediction could be moot if USA Interactive (USAI), Barry Diller's media and electronic commerce company -- and Hotels.com's majority stakeholder -- pushes ahead with plans to buy the 32% or so of Hotels.com shares it doesn't already own. On June 3, USA Interactive announced it would buy out Hotels.com, along with two other companies in which it has big stakes: online travel agency Expedia (EXPE) and Ticketmaster (TMCS), the ticket seller. Two days later, however, Diller put the plan on the shelf after Wall Street pooh-poohed it.

Analysts say it's a matter of when, not if, Diller will renew his offer. "I would tell investors that if they buy Hotels.com, they must buy with the full knowledge that they will likely be owning USA Interactive shares in the next year," says Tom Underwood, a research analyst with Legg Mason in Reston, Va. That's not necessarily a bad thing: USA Interactive, which also owns Home Shopping Network, is admired by Wall Street for its brand-name companies that "provide customer services over the Internet, are highly scalable, and provide tremendous cash flow," Underwood says.

Still, as proposed in early June, Diller's deal wouldn't be a clear-cut boon for Hotels.com stockholders, he says. Because of the drop in USA Interactive's price since the plan was disclosed, the deal as it stands no longer represents a premium. The exchange rate Diller was offering -- 1.8064 USA Interactive shares for each Hotels.com share -- based on June 12's closing price would now be the equivalent of about $44.62, a bit less than Hotels.com's price that day. Underwood, who likes Hotels.com's fundamentals, has a market-perform rating on the shares, due to the confusion over the proposed transaction.

"REALLY STRONG POSITION." Hotels.com's top brass and other analysts maintain that whatever happens, investors will make out well. Robert Diener, the company's president and co-founder, says he thinks if Diller goes ahead with the takeover, the offer price will likely be raised. "Similar transactions have gone through at a premium," says Diener. An independent committee is reviewing the deal for Hotels.com, he adds. "I don't think you can go wrong" investing in Hotels.com at this time, says Paul Keung, a research analyst with CIBC World Markets in New York, who has a buy rating on the stock.

After a successful 2001, when Hotels.com prospered despite a terrible climate for travel-related businesses, 2002 by all accounts looks like another good year. It predicts earnings before interest, taxes, depreciation, and amortization will increase about 56%, to $126.5 million, or $1.44 a share, on revenues of $837 million, also up 56%. "They're in a really strong position as the hotel industry strengthens and moves back to regular pricing," Weinstein says.

Hotels.com was founded in 1991 by Diener and Cornell Law School buddy David Litman, now chairman and CEO. The pair saw opportunity in the remarkably high hotel vacancy rates -- they will average 40% this year, Diener says. If their company could cut deals in the highly fragmented lodging industry to reserve rooms at steep discounts, they reckoned they could rent them out at low rates to budget-minded travelers -- and pocket a hefty fee.

PRESTIGIOUS ADDRESS. In 1996, Hotels.com moved from 800 numbers to the Internet, and it now has some 6,500 hotel contracts worldwide, up from 1,500 just two years ago. It negotiates discounts of as much as 70%, Diener says. Gross operating margins in the first quarter were a higher-than-expected 31.6%, David Richter, an analyst with Salomon Smith Barney, said in a recent note to investors. Hotels.com "is benefiting from the current difficult lodging industry operating environment, as hotel owners leverage each distribution channel to support falling occupancy," he wrote.

The good news is, demand for hotel rooms is expected to increase in the second half as travelers jittery over last year's terrorist attacks start globetrotting again. To capture some of their business, Hotels.com is spending an extra $10 million this year to pitch its new Web site. That's on top of the $12 million or so it had already projected in other marketing expenses.

In the past, customers searching for cheap rooms had to locate the company's hodgepodge of Web sites with relatively obscure names, like 180096hotel.com. Its new address "makes Hotels.com a more trusted brand, and it gives them greater clout with hotels," says Henry Harteveldt, a senior analyst at Forrester Research in Boston.

RESERVATION RIVALS. Despite a makeover of sorts, Hotels.com says it plans to remain true to its so-called affiliates network, which typically has generated up to 65% of the booking volume, Richter says. Under this model, an "affiliate" such as online travel agency Travelocity offers discounted hotel rooms through Hotels.com on its own site. Hotels.com in turn pays the affiliate a transaction fee.

As Hotels.com beefs up its own Web site, the affiliates will continue to represent no less than 50% of gross bookings, Diener says. However, says Richter, "by directing booking volume toward its lower-cost proprietary Web site, [Hotels.com] has the opportunity to significantly improve operating margins."

Hotels.com isn't without competitors. Among them is Expedia, also under the USA Interactive umbrella. A recent check showed Expedia offering a rate of $189 a night at San Francisco's landmark Fairmont Hotel over the July 4 weekend, while Hotels.com was asking $249.95. For other San Francisco hotels on the same weekend, rates at times were the same or lower on Hotels.com. (Hotels.com has a policy of refunding the difference or canceling a reservation without penalty if a customer finds a cheaper rate at the same hotel within 24 hours.)

ROOM FOR GROWTH. Hotels, too, are getting into the online reservations game. Some, such as Westin, are sprucing up their own sites, Harteveldt says. And five majors, including Hilton, Hyatt, and Marriott, have launched a site called Travelweb, offering reservations at their collective properties. Harteveldt says Hotels.com can handle the heat. "[The new sites] will certainly give customers a new choice," he says. "I just don't see them as being quite as extensive as Hotels.com."

Diener, whose company is now in 40 or so European cities and foresees international bookings growth in the triple digits, is hardly daunted. The market is enormous, he argues. And Hotel.com's revenues this year will amount to less than one-third of 1% of the $300 billion lodging market worldwide. "We've barely scratched the U.S. market," he says. "We expect our growth will be substantial for many years."

With no debt and more than $300 million in cash on hand, Hotels.com indeed is a well-positioned dynamo in the fast-growing online travel and leisure business. Of course, the big question for investors remains whether it will grow as part of USA Interactive or as a stand-alone company. By Eric Wahlgren in New York